Which Sectors Should Outperform for the Rest of the Year?

The past decade may provide some clues as to what's ahead

Nobody likes to see summer come to an end, but the autumn months aren’t without their merit. Football starts, the kids go back to school and volume returns to the stock market.

The beginning of September typically kicks off one the most volatile periods of the year for stocks, creating opportunities for traders and investors alike. But are there any sectors of the market more likely to outperform during the final four months of the year?

While seasonal trends aren’t the most reliable guide, a look at the past decade reveals some interesting results — and these may shed some light on the market action of the past month.

The table below uses exchange-traded funds to evaluate the performance of the broader market and its ten major sector components in the September-December period during the past decade:

The data shows some trends that might be of use to investors in the remainder of 2012, among them:

The final four months of the year tend to be positive on balance, despite the sharp sell-offs that have often occurred in September and October.

Not only is the overall market trend positive, but investors have displayed a preference for cyclical sectors (energy, materials and industrials) over the more defensive groups (health care, consumer staples and telecom).

Financials typically underperform and this isn’t just because of the impact the outlier year in 2008. The sector has in fact lagged the broader market in seven of the past ten years.

Technology has a reputation for being the sector most likely to outperform in the September-December period and the numbers bear this out: The sector has averaged a return well above the broader market and has outperformed in eight of the past ten years. However, the emphasis on technology as a second-half winner has obscured the fact that energy has actually been the best sector performer during the period in question.

These results for the September-December period are interesting in light of the current valuation disparities in the market. Last week, CNBC’s Fast Money presented a table showing the massive disconnect between valuations in the defensive, high-yielding sectors versus those in the cyclical areas:

SECTOR

P/E

VS. HISTORICAL AVG.

Utilities

18.3

27% Above

Consumer Staples

18.9

11% Above

Health Care

18.4

7% Above

Technology

16.6

20% Below

Energy

11.7

22% Below

Materials

17.6

25% Below

Put these two factors together — valuations and seasonality — and it illustrates the potential for outperformance by the cyclical sectors through the rest of 2012. Indeed, this sea change might already be underway, if the returns of the ten major sectors since July 31 are any indication:

ETF

RETURN 7/27-8/17

SPY

2.52%

Technology

5.56%

Telecommunications

4.06%

Energy

3.35%

Industrials

3.25%

Materials

3.22%

Consumer Discretionary

2.60%

Financials

2.51%

Consumer Staples

0.81%

Health Care

-0.90%

Utilities

-2.63%

In the near-term, stocks face the potential headwinds of a low VIX and the flood of media hand-wringing that will occur if a slight downdraft causes the major indices to look as though they are forming a double-top. If a correction does in fact occur, this data may provide a clue as to which sectors provide the best opportunity for buying the dip.